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Guidelines for Social Return on Investment

Alison Lingane

Sara Olsen

M ost managers today run their businesses without full informa- tion about the impact of their operations on the environment and human well-being, and thus without the ability to opti- mize these impacts while achieving the financial returns share-

holders expect. Although a number of guidelines and reporting standards have been advanced since the early 1990s, no framework has yet been articulated for quantifying the value of a company’s impact on people and the environment.1

The basic purpose of accounting is to facilitate sound business manage- ment by quantifying the creation of value by firms. However, managers and investors concerned with sound management of firms’ social and environmental impacts will be frustrated in their efforts to use financial accounting for manage- ment of these activities, since standard accounting does not address them. Envi- ronmental and social performance figure in conventional financial statements in only a few high-profile exceptions, such as when a firm’s exceedingly poor envi- ronmental or social practices are brought to light and diminish sales, share price, and goodwill. In such cases, these financial metrics serve as weak, lagging indi- cators that a different management approach would have resulted in less dam- age to both shareholder value and the public’s well-being. These examples point to the fact that a market imperfection exists that can only be addressed if man- agers can identify, interpret, and act upon environmental and social impact information.

Conventional wisdom dictates that financial and social goals are in oppo- sition: economic development versus environmental protection has been framed as a zero sum game in the United States for decades. The real opportunity, how-

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Guidelines for Social Return on Investment

Alison Lingane Sara Olsen

We thank Cathy Clark, Jed Emerson, Will Rosenzweig, and Sanjay Wagle for their contributions to our thinking.

ever, is the “blended value” model articulated by Emerson,2 in which companies achieve both economic success and maximize social benefits. If positive and negative externalities (social and environmental impacts) resulting from com- pany operations were quantified, with metrics that were tracked over time and used to compare impacts across companies, then entrepreneurs, managers, and investors could design, manage, and fund companies to maximize both financial and social returns. Companies that realize this vision must have a social accounting system to augment conventional accounting if they are to measure and manage the full spectrum of value they create.

To date, the effort to develop a practical, comprehensive system to assess the social impacts of business has focused primarily on large corporations and environmental performance management. The first large set of entrepreneurs who have attempted to integrate systematic social and environmental impact tracking into their management accounting systems are those who have com- peted in the Global Social Venture Competition (GSVC), a business plan compe- tition begun in 1999 for profitable businesses with a social mission.3 These entrepreneurs developed quantified projections of their businesses’ potential social impacts, translating the impacts into monetary values where possible. Their “social pro forma statements” lay out high-level performance goals from which performance metrics and data collection systems could flow logically, and taken together they form a comprehensive social accounting framework. If com- bined or integrated with financial accounting, such a framework generates a more complete picture of a firm’s total creation of value.

This article presents an analysis of the patterns evident in the 88 social pro forma statements developed by GSVC entrepreneurs from the years 2000- 2002. All were developed for business plans by seed-stage and startup compa- nies, and they represent a wide range of industries (see Figure 1). To address often-repeated implementation issues affecting the credibility and standardi- zation of these social impact analyses, we have developed a quality standard against which to assess these methods and their implementation, which we call the Standard for Social Return on Investment Analysis (SSROI).

Definitions

While terminology is not yet standardized in the area of measuring social impact, we use the following definitions:

▪ social—This term refers to all of the non-investor stakeholders affected by business: individuals, employees, communities, and society. These stake- holders may also be described as those affected by market externalities.

▪ social bottom line—A term used to represent the social outcome measure- ment that parallels the financial bottom line. The net social benefit from business operations.

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Alison Lingane is Senior Product Manager at Benetech. <[email protected]>

Sara Olsen is the founder of Social Venture Technology & Consulting. <[email protected]>

▪ social return on investment (SROI)—A term originating from return on investment (ROI), as used by traditional investors. It describes the social impact of a business or nonprofit’s operations in dollar terms, relative to the investment required to create that impact and exclusive of its finan- cial return to investors.4

▪ social venture—This term, as defined by the Global Social Venture Compe- tition, is a seed-stage or early-stage business venture that is designed to be profitable and that has an integrated social mission. The social impact of its operations is greater than the industry standard.

▪ sustainable—This term refers to being both economically viable and having a neutral or positive impact on the environment’s ability to sustain itself and on the health and well-being of individuals, society, and communities.

Financial Return on Investment Analysis

ROI is generally understood to be a relative measure of a company’s suc- cess. ROI is calculated to compare companies within a given industry to each other and to their own individual performance over time. An ROI number in a vacuum would not be a useful indicator of a company’s value or of its potential future success; rather, it is a benchmark that quickly gives a sense of the com- pany’s financial situation in a relative context. For example, imagine all we knew about a particular investment was that its projected ROI was 50%. We would have no idea how much money we would get from the investment because the absolute value of the return is unknown—perhaps the return would be 50 cents because the investment amount was only $1. Also, we would not know whether a 50% return was good without knowing what other invest- ments of similar risk would yield. If other investments yielded at least 75%, the 50% return would be a poor choice.

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FIGURE 1. Industry Breakdown of the 88 SROI Analyses

Other

Agricultural Products

Banking/Investments

Job Training and Placement

Education

Biotech/Healthcare

Environment/Energy Efficiency

22%

10%

9%7%

35%

The ROI ratio is a useful management metric. Executives manage their businesses to maximize ROI among other key metrics, knowing that ROI reflects company strength and that shareholders look to it for that evidence. Likewise, investors and managers can use social return on investment to determine a busi- ness’ performance against social and environmental criteria. SROI is a monetiza- tion of the social benefits and costs relative to the financial costs of a company’s operations. It is based on the net present value of these non-market impacts in dollar terms.5 It can be used on an ongoing basis to gauge success and inform the management of social value creation.

SROI analysis is the set of practices necessary to generate meaningful SROI figures and other quantified social metrics. It includes four steps:

▪ collection of ongoing social performance data;

▪ prioritization of data important enough to track;

▪ incorporation of these data into management decision-making and reporting; and

▪ valuation to understand what amount of social value is created or destroyed, and by extension where resources should be allocated.

SROI analysis helps managers and investors accomplish three critical tasks:

▪ plan—It helps entrepreneurs as they plan their businesses to identify business model modifications or alternatives as well as market oppor- tunities that could result in increased social benefits.

▪ manage—It assists management with ongoing operational management and capital allocation decisions by helping them manage and maximize the social bottom line in tandem with the financial bottom line.

▪ assess—It facilitates evaluation of investment opportunities and of their performance with respect to investors’ specific social and financial goals.

Social Return on Investment Analysis

Economists and public policy analysts have used economic models and cost-benefit or cost-effectiveness models for decades to gauge the economic impact of social programs, most often as a policy tool used to influence levels of government spending.6 Cost-benefit analysis is typically carried out either at the outset of an investment to determine whether it is likely to generate benefits superior to the next best alternative, or retrospectively to determine whether the investment was worthwhile. SROI differs from cost-benefit analysis in two criti- cal ways. First, SROI is a practical management tool, enabling informed decision making on a regular basis. A typical social cost-benefit analysis is not used by managers in regular business decision making, instead it is used periodically to determine the least expensive way to provide benefits or to reduce negative impacts to all key stakeholders. Second, SROI enables managers to maximize both social and financial benefits. By contrast, cost-benefit analysis typically frames benefits and costs as trade-offs and does not facilitate planning or priori- tizing that optimizes both financial and social value creation.

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To illustrate SROI calculation, we use the version employed by the Global Social Venture Competition (see sidebar on “Steps in the Calculation of SROI”), which is based on the model first articulated by REDF.

SROI is of little use in the absence of a process framework by which it may be consistently applied by a large number of companies. As with ROI, SROI alone in a vacuum would not be a useful indicator of a company’s value or the potential of its future success; rather, it is a benchmark figure that gives a sense of the company’s situation in a relative context. Our proposal for such a frame- work is presented here as the Standard for Social Return on Investment Analysis.

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TABLE 1. The Standard for Social Return on Investment Analysis

Guideline 10. Include ongoing tracking of social impact.

Note: While the unit of analysis of the SROI is referred to in these guidelines as “the company,” these guidelines are relevant to any entity on which SROI analysis is performed (e.g., a business unit, project, or nonprofit organization).

Construction

Continuity

Guideline 1. Include both positive and negative impacts in the assessment.

Guideline 2. Consider impacts made by and on all stakeholders, including those inside the company itself, before deciding which are significant enough to be included in the assessment.

Guideline 3. Include only impacts that are clearly and directly attributable to the company’s activities. Be conservative with leaps of faith and don’t take credit for more than your organization can realistically affect.

Guideline 4. Avoid double counting the value (financial and social) created by the company and avoid using market valuations of social impacts where they do not reflect full costs and benefits.

Content Guideline 5. In industries or geographic areas in which impacts would be created by the existence of any business, do not count these impacts.The SROI should describe what makes the company different from a standard venture in the industry (i.e., from its competition).

Certainty

Guideline 6. Only monetize impacts if it is logical given the context of the impact, business, or industry.

Guideline 8. Address risk factors affecting the SROI in the assumptions and carefully consider and document the choice of discount rate for social cash flows.

Guideline 9. Carry out a sensitivity analysis to identify key factors influencing projected outcomes.

Guideline 7. Put numeric metrics into context (e.g., this period versus last period, this company versus similar companies) to give the social return on investment meaning.

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Steps in the Calculation of SROI

The fictional example company trains and employs formerly homeless people and provides health care to its employees, resulting in a reduction among the employees in the number of visits to the emergency room per year.The company’s product is a polyurethane (PUR) foam recycling technology that enables PUR foam makers to purchase fewer chemicals per year, resulting in the creation of fewer emissions in the production of those chemicals, among other benefits. For the purposes of a simplified example, we assumed no negative social cash flows.

1. Quantify non-financial impact of operations per unit Example: 10% reduction in visits to emergency room�150 fewer visits per year ; 6% reduction in CO2 emissions per year � reduction of 12,000 tons CO2.

2. Translate into dollar terms per unit to achieve “social cash flows.” Cost per ER visit $250�150 ER visits no longer happening per year� $37,500/year ; Cost per ton CO2 $1.25 based on regional emissions trading markets�12,000 tons reduction per year� $15,000

3. Sum all SCFs for the horizon in question Annual social cash flow is $37,500�$15,000�$52,500 There is currently no standard time frame for social return on investment pro- jections. Five years is used since projections beyond this time are so uncertain as to be meaningless, and since this is typical for financial projections among startups.

4. Discount SCFs to present value** Discount each year’s summed social cash flows by an appropriate discount rate. Document all assumptions. There is at present no market standard for determining the appropriate discount rate.This issue is discussed further in this paper.

Present Value of Social Cash Flows Year 1 Year 2 … Years 1-5

52,500/(1�.20)� 52,500/(1�.20)2� � $171,993

5. Divide by investment to date� SROI

Year 0 – investment Year 1 Year 2 Year 3 Year 4 Year 5

$ (100,000) $36,451 $25,308 $17,571 $12,200 $8,470

PV of SCFs $157,007 Investment $100,000 SROI 157% SIRR* 44%

*SIRR is preferred by some investors. It is the discount rate at which all cash flows including investment sum to zero.

**Any errors in PV calculations are due to rounding.

The Standard for Social Return on Investment Analysis

Guideline 1. Include both positive and negative impacts in the assessment.

To draw a complete picture of the value it generates, a company must account for not only the positive social impacts resulting from its operations, but also the negative social impacts. Most often, however, entrepreneurs in the sam- ple failed to even consider the various negative impacts of their operations. For example, the business plan of a paperless company claimed the environmental benefit of reduced paper use as part of its potential social return. However, it did so without any discussion of the relative impact of the substitute: computers and the impact of their manufacture, operation (through energy-related pollution), and disposal. Similarly, a solar energy company gave no attention to the relative environmental impact of the manufacture, distribution, and maintenance of solar panels.

Guideline 2. Consider impacts made by and on all stakeholders, including those inside the company itself, before deciding which are significant enough to be included in the assessment.7

Typical startup business plans contain little or no detail regarding specific internal policies and practices affecting financial performance. The majority of business plans in the sample focused on assessing the external impacts of their organization and ignored social impacts resulting from internal operations. However, since one goal of SROI analysis is to assist companies in growing while also achieving greater sustainability for both internal and external stakeholders, consideration of the social impact of internal practices is important. Internal evaluation should reflect consideration of such things as the company’s culture and supplier relationships. It should also include assessment of activities such as energy and waste management and the corresponding effect on the environ- ment, as well as assessment of employee satisfaction and its effect on retention.

One firm in the sample planned to produce air conditioning optimizers— machines that reduce overall energy consumption of commercial air condition- ing units. In its business plan, the company did not mention that it planned to use its own air conditioning optimizer in its own facilities, or assess the cost sav- ings that might result. Although the company would have been too small to use its product during start-up, an in-depth internal analysis through its growth should have included the use of its own air conditioning optimizer, among other internal practices.

A recurring question is whether the company can actually claim respon- sibility for the impacts included in its analysis. In some assessments in the sample, entrepreneurs credited themselves with social impacts that were not the direct result of company activities. One company, with a software tool to

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help microfinance institutions manage their loans, claimed the full benefit from all of the activities of the microfinance institutions. Another consulted to compa- nies around bioethics, and claimed the full social benefit of the products on which it consulted.

Several companies whose activities were projected to result in donations to nonprofits, or whose measured social impact was based solely on a percentage of company profits allocated for charity, claimed the dollar figure of these funds without considering the social impact of those funds once they were donated. It is a common, though seriously mistaken, assumption that simply increasing money flow into nonprofits equates to positive social impact.

Guideline 4. Avoid double counting the value (financial and social) created by the company, and avoid using market valuations of social impacts where they do not reflect full costs and benefits.

The companies in the sample were asked to prepare both financial and quantified social impact projections. This resulted in some double counting: some companies meant to quantify their social return on investment, but counted their financial impact instead. For example, one company used revenue generated from the recovery of waste gas as a measure of its social impact, rather than quantifying the environmental value gained. Here, good old-fashioned financial returns were confused with the public benefits of an incrementally cleaner environment.

In another example, a coffee producer counted the value of its sustainable farming practices to be the $0.50 per bag of coffee that consumers were willing to pay for their sustainably grown coffee. Measuring the social impact by the market value of the perceived benefit, called contingent valuation, works only if the market is good at valuing all of the externalities that affect all relevant stake- holders. Making this distinction can be tricky, but it is critical: the essential ratio- nale for calculating SROI separately from financial returns is because the market’s valuation of social benefits is imperfect. In cases where it is perfect, there would be no need for an SROI analysis.

However, there is a difficulty in determining a comprehensive, valid, reli- able value for a given impact when there is no market-based price for it. Over time, one of the great potentials of the widespread use of high-quality, standard- ized SROIs is that market prices could begin to reflect the true value and cost of social impacts, or that proxy markets for units of social impact could be estab- lished enabling companies to capture their social value creation. It is left to the interested parties to determine whether a dollar value derived from market prices is sufficiently inclusive of the full value or cost of a social impact. In cases where it is not, a social impact valuation must factor the full dollar cost or value to society of the impact in question. When even this is incomplete, the monetary social impact value must be accompanied by a discussion of the value inherent in a given impact that is not monetizable or even quantifiable.

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Guideline 5. In industries or geographic areas in which impacts would be created by the existence of any business, do not count these impacts. The SROI should describe what makes the company different from a standard venture in the industry (i.e., from its competition).

In the same way financial analysts need to understand a company’s com- petition to truly understand the context of financial performance numbers, understanding a company’s social impact requires comparison of a businesses’ social performance to the next best alternative. As noted, there are some industries with very clear social benefits built right into the product or service —e.g., health care or energy-efficient products. When socially aware investors concerned with financial and social returns make decisions about investments in such industries, they still need to be able to judge a given company’s social per- formance relative to others. Similarly, for managers to know if they really are making progress and maximizing their potential positive social impact, they need to know how they are performing relative to their industry peers.

Take the case of a drug company that improves people’s health through the sales of its drug. Given that the company’s financial success depends upon the company creating the social benefit of improved health, is it fair to claim these benefits as the company’s social impact? Merely knowing that a benefit is created is not sufficient to inform an investment decision: even a health care company must strive to make its social impact greater than its peers’ before it can claim to have a large SROI.

In a similar vein, there are situations in which any company in a partic- ular region would have comparable social benefits. Consider a company that locates in a developing country and claims economic development benefits. In regions where there is little economic activity of any kind, the presence of any company offering jobs may represent a significant step forward in the quality of life for community members. However, if the business is no more socially and environmentally responsible than other companies in the region, how does one judge social impact? In such a case, including the company’s benefits relative to the alternative of little or no economic activity would be reasonable. In well- established industries in thriving economies, on the other hand, the context dictates that social impact must outstrip that of peer firms. In between lies a gray area, which is why continually raising the social perfor- mance bar is essential to meaningful impact assessment: a paying job is better than no job, a living wage job is better than a subsistence wage job, and so on.

The quantitative analysis of a company’s impact should always begin from a theoretical ideal of zero negative impact, but information on how the company’s performance compares with the next best alternative in its market- place must be provided to give the SROI context and meaning. It is virtually impossible for any company in the present market context to be perfectly free of any negative impacts. When properly calculated, SROI reflects the relative improvements in well-being that a business delivers over the status quo, and thereby SROI becomes useful as a management and analytical tool. If we value companies’ marginal improvements in social impact relative to their peers and

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base capital allocation and investment decision on these valuations, over time, market forces will drive industries toward sustainability.

Guideline 6. Only monetize impacts if it is logical given the context of the impact, business, or industry.

As noted, a monetized social return on investment alone—even one that avoids some of the problems outlined in these guidelines—is not enough to pro- vide investors and managers with an accurate assessment of the social perfor- mance of a company. Monetization enables the analyst to deduce complex information into data that can easily be compared and valued. At the same time, it may be difficult or misleading to summarize all impacts in one number. To overcome this, one business plan for a solar energy technology for use in devel- oping countries identified multiple metrics to explain the company’s impact, from electricity savings to increased quality of life to projected lives saved due to reduced harmful pollutants. Not all of these impacts (such as increased quality of life) could be accurately monetized, and some (such as lives saved) could not be meaningfully reduced to monetary terms alone.

When monetization is appropriate, one common technique is to use com- parison costs, or how much money it would cost to create the same benefit. For example, one plan measured the value of increased voter turnout by the cost to register additional voters. Another intriguing technique was to estimate the value of some benefits by analyzing what one would pay for a guarantee of that benefit, a technique that factors risk into the valuation of the specific benefits.8

However, users of these techniques should avoid confusing these approaches with the market’s valuation of the benefit (which, as noted, is not presently based on impacts on all relevant stakeholders and thus is not an accurate reflec- tion of the public cost or benefit).

Companies should test and identify metrics that work best for their partic- ular industries. As the practice and methodologies of social return on investment progress, it may be possible to standardize some measurements in the same way financial reporting has been standardized.

Guideline 7. Put numeric metrics into context (e.g., this period versus last period, this company versus similar companies) to give the social return on investment meaning.

As a widely-used introductory financial accounting textbook states:

Ratios, by themselves out of context, provide little information. For example, does a rate of return on common shareholders’ equity of 8l.6 percent indicate satisfac- tory performance? After calculating the ratios, the analyst must compare them with some standard. The following list provides several possible standards for comparison:

1. The planned ratio for the period

2. The corresponding ratio during the preceding period for the same firm.

3. The corresponding ratio of a similar firm in the same industry.

4. The average ratio for other firms in the same industry.9

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In the same way, the SROI ratio itself, which ultimately coalesces the company’s social performance into a single figure, cannot possibly tell the whole story of the company’s social impact without a well-understood context.

Guideline 8. Address risk factors affecting the SROI in the assumptions and carefully consider and document the choice of discount rate for social cash flows.

The choice of discount rate can dramatically change the result of a quanti- fied social return on investment. Many entrants used the municipal bond rate (ranging from 4.3-5.0%); other entrants used the 30-year Treasury bond rate, making the argument that they were saving federal and other governmental funds through their activities. Some of the discount rates with sound supporting arguments were based upon the cost of capital, while others were based upon estimates of the risk inherent in realizing the social impact.

One business, a health care management software firm called Cask Solutions, presented a particularly well-conceived rationale for its chosen dis- count rates.

A larger discount rate generally implies a larger risk. From the perspective of Cask Solutions, we evaluated how risky our expected social returns would be relative to our financial returns. We recognize that calculating a social benefit is reliant on many assumptions. This process thus broadens the “band” within which we expect the real social return to fall, and a higher discount rate would be appropri- ate to reflect the risk associated with the fact that some social benefits may not accrue as expected. Furthermore, because the social benefits are believed to be tightly linked with the use of Cask Solutions’ products, we would expect that the risk of achieving our social benefits should be in line with the risk of the enter- prise returns, suggesting the use of a discount rate similar to our enterprise dis- count rate [which was calculated using comparables at 18.9%]. We have evaluated all these options in a sensitivity analysis, and believe that 25% is the best rate to use, reflecting the most realistic assessment of risk.10

Cask’s rationale was accompanied by a sensitivity analysis showing the social returns resulting from the application of discount rates ranging from 3% to 30%.

The area of discount rates for quantifying monetized social returns needs further research to enable as rigorous a selection of discount rates as can be done for financial valuations. At present, the best solution to the question of discount rates is to use one that reflects the uncertainty of the projections of the com- pany’s financial success and effectiveness achieving its social impacts and includes consideration of the time required before social impacts are evident.

Guideline 9. Carry out a sensitivity analysis to identify key factors influencing projected outcomes.

Only nine percent of the assessments in the sample provided a sensitivity analysis to test what effect different assumptions had on the projected SROI figure. Sensitivity analysis is useful in understanding both the SROI analysis and the likely social impact. Given the current lack of standards in measuring social

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impact, having a sense of both the range of possible impacts, and how depen- dent they are on key assumptions, is especially important.

Guideline 10. Include ongoing tracking of social impact.

A key problem uncovered in the review of the plans was the lack of inte- gration of the SROI into business operations. Among the few plans that included ongoing impact tracking, the most common method was an annual social audit to be presented to the board. Without more details on how the audit criteria were to be developed or what standard would be used, it is hard to determine the usefulness of this approach. Many of the impacts that need to be tracked require that a system be in place that captures more data than those already tracked for financial accounting purposes. The OASIS methodology, the Balanced Scorecard, and other ongoing performance management practices pro- vide examples (see Appendix B).

Cost Accounting

Many assessments in the sample arrived at a monetized social benefit figure by taking the total social benefits over the total time horizon and subtract- ing a lump sum defined as the “social cost.” In most cases, this “social cost” was actually the financial expense to the company of generating the social benefit, not the negative social impacts. This calculation mixes apples and oranges. The correct calculation is modeled after the Return on Investment or Return on Assets. It should be done on an annual basis subtracting the negative social impacts from the positive social impacts. To compare the net social outcome to the investment or asset base, the financial expense figure can be used to calcu- late SROI or social internal rate of return, or an asset figure could be used to calculate social return on assets.

In sum, social return on investment analysts should base their numbers on sound data, they should accurately represent the certainty of claims, and they should have a plan for continuous collection and management of social impact data. They should consider all significant impacts and make only reason- able claims of causality. This will make SROI useful to managers and investors, help them see where their understanding of their impacts is weak, and encour- age them to plan ahead to optimize social impact into the future.

Issues and Limitations of Social Return on Investment

Even when the SSROI is followed, several issues need to be considered when interpreting the results of an SROI analysis.

Social Impact Can Be a Personal or Political Measurement

Social return on investment analyses often involve subjective value judgments regarding the measured outcomes. For SROI to make any sense as a tool by which to judge businesses, it must be considered within the political

environment and the personal goals of the entity performing the analysis. Con- sider the case of a biotechnology firm that produces a life-saving medication that is used both in the U.S. and in the developing world. The issues—such as how much weight to give each group when the SROI monetization reflects lifetime earnings potentials that are far greater in the U.S. than in the developing world —reflect the goals of the investor or management as much as the facts. If the tool is being used within a private organization, the foundation or firm can address this by clearly outlining its own desired social goals. However, if the goal is a broader one, tough collective decisions will need to be made about what defines positive and negative impacts.

Quantification

In the absence of consistent standards, many factors must be considered to determine what social outcomes are appropriate for use in an SROI.11 First, there are issues of data quality and availability:

▪ measurement—Appropriate data and research linking business outcomes to quantified social impacts may not be available.

▪ causality and correlation—There may not be a strong correlation between business outcomes and a monetizable economic return to society.

▪ timeframe—When the impacts of a business lead far into the future, there is often uncertainty whether long-term benefits will actually be realized and, if so, whether they are the result of earlier activities.

Second, SROI should not be used to compare two or more different busi- nesses, or businesses in different industries, unless the method used to generate the analysis was consistent. Differences in outcomes measured, measurement methods, and data sets used can significantly affect the SROI calculation and, if not standardized, could result in comparisons that are of little value.

Third, when using SROI to compare two seemingly similar organizations, the different starting points of those organizations relative to the achieved social outcomes should be considered. Take the example of two businesses that serve as job training programs for “at risk” populations. Employing one population versus another may inherently be more difficult or costly given the organiza- tions’ different missions (imagine two youth programs, one for high school college-track students and the other for homeless teenagers). If the metric of success of both programs is the percentage who find gainful employment outside their enterprises, the success of the organization that trains high school students may appear to be higher, resulting in a higher SROI valuation. The greater diffi- culty of serving homeless youth needs to be factored into the valuation such as with a “difficulty coefficient,” or otherwise made clear so that investors can make informed decisions.

Absence of Data from Large Numbers of Companies

Today, SROI analysis is valuable as a means of catalyzing opportunity recognition and of aligning investor/enterprise expectations, which are critical to

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the success of an early-stage investment. Having a preliminary understanding of specific social impacts is a vast improvement over having only a general idea that positive impact may be taking place. However, in the absence of social impact data from large numbers of companies to enable industry-wide analysis, those seeking full context for their SROIs will be frustrated. If sufficient numbers of enterprises with similar social outcomes were to develop SROI analyses, we could begin to determine whether difficulty coefficients and other such variables could be ascertained.

One of Many Measures of Success

SROI cannot and should not be used as the sole indicator of social per- formance, in the same way that ROI is not used as a sole indicator of financial performance. Instead, as with financial metrics, having both additional quanti- fied outcome measures and a qualitative, narrative description (as in a standard annual report) is the only way to gain a more complete understanding of a busi- ness’ social impact.

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SROI Use in Operating Companies

Following are four companies in operation in 2004 that have experience using SROI in their fundraising and day-to-day operations.

Wilson TurboPower (GSVC winner, 2002)

Wilson TurboPower (<www.wilsonturbopower.com>) is a provider of efficiency- enhancing technologies for power generation and vehicle propulsion systems.The company is commercializing a revolutionary heat-exchanger technology called Indexed-Rotation Regenerator that was developed in the labs of MIT.The heat- exchanger technology can deliver up to 30-fold savings to users in such industries as refrigeration and high-temperature energy technology.

Now in its second year of actual operations, Wilson TurboPower has five employees. The company expects about $0.75 million in revenue in 2004 as it makes its first sales in this $30-40 billion industry. “We’ve experienced big pull from corporate customers and serious interest from big institutional buyers such as the military and NASA,” said CEO Joern Kallmeyer.The company has found that many potential corporate customers are as interested in the cost savings their technology provides as they are in the opportunity to demonstrate to their own customers their com- mitment to cleaner technology. Wilson TurboPower expects to be cash flow positive in 2005.

Wilson TurboPower’s social return is an inherent piece of its operations, given the technology it developed.The company was founded by a group of people with strong beliefs in the principles of social return. Wilson TurboPower’s fundraising experience

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is indicative of the perception of SROI today within the funding arena.The company’s social return on investment analysis was helpful in articulating the non-monetary benefits of its products, especially for government funding sources. On the other end of the spectrum, mainstream venture capitalists were almost exclusively focused on the revenue and cost projections. A minority of angel investors the company inter- acted with were in the middle: they were interested in social return within their spe- cific niche of funding focus (e.g., the environment). Kallmeyer estimates that for about 10% of their investors to date, the decision to invest was influenced by the social impact of their company.

Mobius Technologies

Mobius Technologies (<www.mobiustechnologies.com>), incorporated in 1997, has a proprietary recycling technology for polyurethane foam scrap. With it, furniture and car manufacturers can recycle all their foam scrap, saving up to 20% in raw materials and cutting waste disposal to zero.The Mobius process turns scrap polyurethane foam into a fine powder, which can then be used in place of virgin chemicals to manufacture new foam.The new foam retains the properties of the original foam, so savings are found in the difference between the resale value or disposal cost of the scrap and the price of virgin chemicals.

Since the company’s inception, its management has studied the economic, environ- mental and health benefits of its recycling. In 2001, Mobius developed an SROI analy- sis to demonstrate—to potential investors, customers, and strategic partners—the environmental and health value of installing Mobius equipment.The analysis identified hundreds of thousands of dollars per year, growing to millions, that the company and its strategic partners could capture by trading its environmental benefits on the emis- sions credit trading markets in the U.S., EU, and developing countries—which previ- ously Mobius and its investors had overlooked.

CEO Bryan Martel said, “We were deliberately looking for investors aligned with both our financial and environmental value propositions. Our SROI greatly exceeded the expectations of our investors. We believe having it expedited our funding discus- sions with these investors.” Mobius was the first U.S. company to secure investment from a major, private China-based clean technology venture fund.The SROI analysis also led to discussions with Dow Chemical Company regarding the value of emission credits it may capture as a result of its Mobius strategic partnership.

Bronx Charter School for the Arts (GSVC winner, 2003)

Bronx Charter School for the Arts (<www.bronxarts.net>) is a charter elementary school “founded on the principle that arts education is instrumental to learning and human development.” It combines daily teaching in various arts disciplines with rigorous instruction in all subject areas.The school opened in September 2003 after thirty months of planning.Today its annual operating budget is $1.8 million, which

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comes from the state of New York and foundations. By 2008, its operating budget is projected to be $3.8 million.

In 2004 it will complete its first year of operations and be able to evaluate for the first time whether its educational plan has worked.The school assesses the success of its educational plan with a 4-faceted approach that tracks: student performance through standardized and locally developed assessments); parent satisfaction through student retention, attendance, and surveys; staff satisfaction through staff retention and surveys; and financial performance, by such measures as whether its revenue targets were reached and the quality of its audit ratings.

Bronx Charter’s SROI factors the long-term impact of the school’s educational model on students’ lives through such measures as economic productivity, rates of welfare dependency, and criminality.The school’s senior management said the SROI analysis completed during their business planning process was a useful long-term visioning exercise, but was not useful for tracking short-term performance now that the orga- nization is focused on daily operations. “For the SROI, we had to think long term because the monetizable impacts of education aren’t realized until kids get out there into the job market.” Now that it is in operation, Bronx Charter monitors its perfor- mance against a shorter time horizon based on the assumption that if the school does a good job students won’t need to repeat grades, there will be less juvenile delinquency, and so forth. “The things we track on a day-to-day basis are day-to-day things,’” said Executive Director Xanthe Jory, “like attendance and how well is this student performing on reading from August to December to June.”

Jory said she thought there were industries or types of companies for which SROI analysis would have a more practical application than in early education. “The com- mon thread is the immediacy between the service or the product, and when the benefit from it is reaped.” She elaborated, “I think SROI could be compelling in our field today if research existed that said, for example, what is the link between perfor- mance in first grade and graduation rates in high school, or the link between gradua- tion rates and whether you’re going to be on welfare, or those kinds things. It would be helpful if studies tracing that existed and were accessible. An SROI clarifies the need for and value of that evidence.”

Because of the unavailability of these kinds of studies, Bronx Charter has not found SROI to be useful in its fundraising from government and foundation funders. Said Jory, “I wish I could say that our funders asked for the social return on investment, but they don’t. If I felt we could link it to research to make it credible, I would send it to them anyway.”

Calvert Social Investment Foundation Community Investment Note Program

Calvert Social Investment Foundation (Calvert Foundation) is an independent 501(c)3 non-profit enterprise associated with the Calvert Group mutual fund company. Calvert Foundation’s mission is to help end poverty through investment. It serves as an intermediary for individuals and institutions seeking to place capital on below-

Conclusion: The Opportunities and Challenges of Social Return on Investment

This study is based on projected, not actual, assessments of social impact. To determine the true value of SROI, companies will need to create SROI analy- ses based on their actual performances. However, this study indicates that the process of calculating an SROI, actual or projected, can help companies identify opportunities to create social value and increase financial value. For example, as a result of its analysis, a packaging technology company in the sample (which used molded fiber as its feedstock and was primarily environmental in focus) realized that the majority of its positive quantifiable social impact stemmed from its “Township Model” of employing low-skill workers at small-scale factories in urban industrial centers. Other companies had insights about which markets to enter first to generate the largest financial and social impacts. In the absence of the social consideration, they found that they would have probably chosen a different route to achieving similar financial returns (in other words, they would have generated financial returns at a “social opportunity cost”).

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market terms to finance affordable homes, fund small and micro businesses, and to make available essential community services.The foundation’s broader objective is to promote investment that advances community development goals within the financial services industry at large.

The Foundation employs a range of innovative financial instruments, web-based infor- mation services, and philanthropic products (including the Calvert Community Invest- ment NoteTM), which pay a fixed rate of interest (0, 1, 2, or 3 percent—determined at the time the investment is made) for the term of the note (options from 1 to 10 years). Loans are then made to community development and social enterprises in the U.S. and throughout the world.

For several years, the Foundation has worked to incorporate social performance assessment into its processes. In 2001, Calvert developed a first-generation “SROI calculator” on its web site to enable investors to calculate the approximate number of jobs, units of housing, and nonprofit facilities created by an investment in a given region, computed against the amount and term. As part of its due diligence process, the Foundation collects social returns data annually from each portfolio organization.

“We believe the field of community investment can and should demonstrate its development impact in measurable terms, and our social return is therefore an inte- gral part of our business,” said Tim Freundlich, Director of Strategic Development. “Right now SROI is primarily useful as a marketing and reporting tool to our invest- ors, but we are committed to cultivating our data to the point where they help investors determine how to get the maximum social return on their capital, and determine how that relates to their financial return goals.“

It is the prevailing assumption in business that opportunities to create social benefits detract from financial performance. As a result, most entrepre- neurs and investors do not perform any sort of SROI. Entrepreneurs’ time and financial constraints are typically severe, and in practical terms they are unlikely to spend time on such assessments unless it is seen as important to their investors. However, the reality is that a reasonably thorough projection of social impact is not prohibitively expensive even for early stage companies. The price of a projected SROI like those in this study ranges from zero to a few thousand dollars. Some benefits may result from analysis of projected SROI even without ongoing tracking efforts.

The quality and consistency of the SROI analyses, however, is critical for their value to companies, investors, and the public. The Standard for Social Return on Investment Analysis presented here can help investors, managers, and analysts to account for companies’ social performance in a reliable and cred- ible manner. Such social accounting should be made publicly available to inform the general public of companies’ social performance and to enable industry-wide analyses. However, this will only happen if the sources of capital require it.

APPENDIX A Overview of the Global Social Venture Competition

The Global Social Venture Competition is a business plan competition for profitable startups with an integrated social or environmental mission. Originally called the Haas Social Venture Business Plan Competition, it was started in fall of 1999 by five MBA students at the Haas School of Business at the University of California, Berkeley. (The authors were two of the co-founders of the Compe- tition.) GSVC partnered with the Goldman Sachs Foundation and the Columbia Business School in 2001, and with the London Business School in the summer of 2003.

The GSVC is run very much like a traditional business plan competition (one that has no special requirement for the businesses to have a social or environmental mission). Its judges typically include experienced investors and entrepreneurs from both traditional and socially or environmentally oriented backgrounds. A smaller number of nonprofit and foundation leaders have rep- resented the philanthropic “investment” perspective.

What makes the GSVC unique are the defining social venture criteria it demands of entrants:

▪ core mission—Each entrant’s business must have at the core of its mission and operations a social or environmental purpose.

▪ self sufficiency—Plans may be for-profit businesses or businesses owned by nonprofits; however, regardless of tax status, the plans must be at least self-sustaining through revenue generation or be profitable.

▪ quantified social impact assessment—In addition to the traditional financial statements, an analysis of the business’ or organization’s social impact is required. This must include a quantitative summary of impact.

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▪ industry standard—Plans’ social impact must be an improvement over the industry standard.

The competition founders established these criteria based on three beliefs about the nature of business: that business can be sustainable; that for business to be sustainable it is necessary to understand and manage the costs and benefits of operations on people and the environment as well as on the bottom line; and that understanding costs and benefits requires tracking them systematically. The stipulations were intended to assist judges and entrants in understanding how to present and assess information about the relative merits of the entrants’ ventures.

APPENDIX B Examples of Valuation and Management Process Methodologies

Valuation Methods The following methods are typically used for snapshot social “valuations”

by investors and business or nonprofit managers, and come primarily from non-profit social ventures, government organizations, and socially oriented investors. A point worth noting is that methods that address social values are rooted in cost-benefit analysis and, as such, remain separate from attempts to assess the inherent or moral “value” or worth of a given enterprise.

▪ AtKisson Compass Assessment for Investors—This method evaluates social and environmental impacts in four comprehensive areas derived from corporate social accountability standards plus a fifth area called “Synergy” between these areas, and assigns a numeric rating to the venture’s per- formance in each area (<www.atkisson.com>).

▪ Global Social Venture Competition SROI—This method blends the IFC and REDF models in a five-step approach (outlined in Figure 1 above). Entrants to this business plan competition use the method to project the social impact of their startups (<www.socialvc.net>).

▪ REDF’s Social Return on Investment (SROI) Framework—This method is par- ticularly geared toward nonprofits running businesses that hire and train populations with above average unemployment and below average job success. It facilitates evaluative or projective estimation of the incremental social benefit of the enterprise (<www.redf.org>).

▪ World Bank International Finance Corporation’s Economic Rate of Return (ERR)—This method is based on a benefit-cost framework and entails a monetized assessment of a given project in comparison to its next best alternative (<www.ifc.org>).

Management Processes The following methods focus on the ongoing process of performance

monitoring and have emerged from the corporate social accountability and corporate strategy disciplines.

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▪ Balanced Scorecard—This method creates ongoing internal benchmarks for four major areas of importance to a venture’s success with the goal of balancing financial interests with other organizational and constituent goals (<www.bscol.com>).

▪ REDF OASIS—This method uses management information systems (MIS) customized to the data tracking needs of specific nonprofits. It is used to aid in the management of the overall nonprofit as well as its social enter- prises (<www.redf.org>).

Notes

1. The nonprofit sector’s concurrent increased focus on quantified outcomes measurement has contributed to the development of Social Return on Investment analysis. However, even the nonprofit sector still lacks a standardized framework for outcomes measurement or social accounting despite the fact that its existence is defined by its social value.

2. Jed Emerson, “The Nature of Returns: A Social Capital Markets Inquiry into Elements of Investment and the Blended Value Proposition,” Social Enterprise Series, No. 17, Harvard Business School, Boston, MA, 2000. Similar arguments, particularly about the financial rewards of environmental sustainability, have been made by others such as Paul Hawken, Amory Lovins, and L. Hunter Lovins, Natural Capitalism: Creating the Next Industrial Revolution (Boston, MA: Little, Brown and Co., 1999); Paul Hawken, The Ecology of Commerce: Doing Good Business (New York, NY: HarperCollins Publishers, 1993).

3. See <www.socialvc.net>. 4. We use this term generally to refer to the SROI analyses developed by the Roberts Enterprise

Development Fund (<www.redf.org>) unless otherwise noted. 5. The concept of SROI as applied to nonprofits has been articulated in “SROI Collection,”

Roberts Enterprise Development Fund, 2001, <www.redf.org/pub_sroi.htm>. Guidelines for the concept’s application to for-profit startups have been published on the Global Social Venture Competition web site, <www.socialvc.net>.

6. Henry M. Levin, Cost Effectiveness: A Primer (Beverly Hills, CA: Sage Publications, 1983). 7. For assistance in prioritizing the most effective environmental practices, see Michael Brower

and Warren Leon, eds., The Consumer’s Guide to Effective Environmental Choices: Practical Advice from the Union of Concerned Scientists (New York, NY: Three Rivers Press, 1999).

8. A topic worthy of further exploration is the relationship between social return on invest- ment and the analytical models and tables that enable actuaries to assign prices to such things as snowfall, lives, and body parts.

9. Clyde P. Stickney and Roman L. Weil, Financial Accounting: An Introduction to Concepts, Methods, and Uses, 8th Edition (Forth Worth, TX: Dryden Press, 1997).

10. Katherine Kim, “Cask Solutions, Inc. Business Plan,” 2002. 11. Much of this discussion is adapted from Jessica Lindl, Alison Lingane, and Liz Walters,

“Social Return on Investment: A Practitioner’s Perspective,” unpublished paper, 2000. These issues have also been discussed in the REDF SROI Collection, including Cynthia Gair, “A Report from the Good Ship SROI,” 2002, <www.redf.org/pub_sroi.htm#overview>.

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